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Risk Management and Insurance: Perspectives in a Global EconomyRisk Management and Insurance: Perspectives in a Global Economy
24. Regulation and taxation in 24. Regulation and taxation in Insurance MarketsInsurance Markets
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Points to PonderPoints to Ponder
Insurance regulation
Taxation in insurance
Insurance Regulation
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Evolving International Insurance Markets Evolving International Insurance Markets (Figure 24.1)(Figure 24.1)
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Insurance Regulation TrendsInsurance Regulation Trends
Countries worldwide began moving toward more liberal (i.e., freer) markets and away from more circumscribed markets.
Countries have moved from more to less restrictive insurance markets.
They have increasingly embraced competition and eschewed special interest regulation.
The great majority of the world’s largest 50 insurance markets are more liberal today.
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Mechanisms of Insurance RegulationMechanisms of Insurance Regulation
LegislativeFormation and licensing of insurers
Licensing of agents and brokers
Filing and approval of insurance rates
Filing and approval of proposal material and policy forms
Unauthorized insurance and unfair-trade practices
Insurer financial reporting, examination and other financial requirements
Rehabilitation and liquidation of insurers
Guaranty funds
Insurance product and company taxation
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Mechanisms of Insurance RegulationMechanisms of Insurance Regulation
JudiciaryIt resolves disputes between insurers and policyholders.
It enforces insurance laws through orders supporting the insurance supervisor and by assessing civil and sometimes criminal penalties against those who violate insurance law.
Insurers and intermediaries occasionally resort to the courts seeking to overturn arbitrary or unconstitutional statutes, administrative regulation and orders promulgated by regulators.
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Mechanisms of Insurance RegulationMechanisms of Insurance Regulation
ExecutivePolicymakers commonly delegate this authority to a ministerial department of the government.
In most countries, a special department or subordinate institution of the relevant ministry carries out insurance regulatory oversight. The department can be
Explicitly for insurance regulation and supervisionPart of a larger institution that also oversees bankingPart of the bigger financial supervisory agency
A formal advisory body assists regulatory authorities in most countries (but not typically in the U.S.).
The regulatory situation in the E.U. is unique.
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Approaches to RegulationApproaches to Regulation
Ex-ante regulation
Ex-post regulation
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Areas of RegulationAreas of Regulation
Access to the Market
Balancing competition against consumer protection
Detecting insurer financial difficulty
Responding to insurers in financial difficulty
Protecting insureds of an insolvent insurer
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Areas of Regulation Areas of Regulation (Figure 24.2)(Figure 24.2)
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Regulation -- Controlling Access to the MarketRegulation -- Controlling Access to the Market
The role of government as a supplier of insurancePrivatization
Licensing requirementAdmitted vs. nonadmitted insurers
Nondiscrimination and national treatment
Permitted organizational forms
Ownership restrictions
See also Chapter 20.
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Regulation -- Controlling Access to the MarketRegulation -- Controlling Access to the Market
Restriction on business scopeRestriction to the conduct of insurance business
Separation of classes of insurance business
Right of appeal
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Regulation – Balancing CompetitionRegulation – Balancing Competition
Rate and product regulation
Financial regulation
Intermediary regulation
Competition policy regulation
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Regulation – Balancing CompetitionRegulation – Balancing Competition
Rate and product regulationRates are not excessive, unfairly discriminatory or inadequate.
Types
Tariff markets
Prior approval system
Flexi-rate system
File-and-use (use-and-file) system
Open competition
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Regulation – Balancing CompetitionRegulation – Balancing Competition
Financial (prudential) regulationMore restrictive financial regulation is associated with more secure insurers.
Nevertheless, extensive restrictions stifle competition and innovation and, thereby, can lower consumer value and choice.
The more competitive a market, the more important is prudential regulation.
AreasOngoing capital regulation
Asset limitations and valuation
Liability regulation
Accounting standards
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Ongoing Capital (Solvency) RegulationOngoing Capital (Solvency) Regulation
Solvency marginsWithin the E.U. (and many other countries), minimum ongoing capital and surplus requirements are set out.
Solvency I
Solvency II
Risk-based capitalAs in the U.S. and several other countries, minimum acceptable capital for business continuation of an insurer
Insight 24.1 (U.S. RBC regulation)
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Asset Limitations and ValuationAsset Limitations and Valuation
Authorized (admitted) investments
Diversification
Currency matching (congruence)
Localization
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(Accounting) Liability Regulation(Accounting) Liability Regulation
Life insuranceIn some countries, the regulator prescribes in detail the methods and assumptions used to derive life insurer technical (mathematical) reservesIn other, the regulator relies on an actuarial valuation.
Nonlife insuranceNational laws are more general for nonlife insurers
Appropriate loss reserve establishment has been a regulatory challenge.
The discounting of loss reserves is not, in general, practiced.Some countries make no provisions for claims incurred but not reported (IBNR) losses.
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Accounting StandardsAccounting Standards
Statutory accounting principle (SAP)
Generally accepted accounting principle (GAAP)
International Accounting Standard Board (IASB)For standardization of accounting principles internationally
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Intermediary RegulationIntermediary Regulation
The services of knowledgeable intermediaries are important in highly competitive than in more restrictive markets.
Because individuals and businesses rely on the advice as well as risk management and insurance services of such intermediaries, they should be knowledgeable, trustworthy advisors.
Minimum qualification requirements in most countriesU.S. E&S broker license as an example of a special case
The importance of intermediary regulation as financial services sectors converge.
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Competition Policy (Antitrust) RegulationCompetition Policy (Antitrust) Regulation
Typical elements of competition lawCollusive practices
Horizontal collusion
Vertical collusion
Conglomerate collusion
Mergers and acquisitions
Abuses of dominant position
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Competition Policy (Antitrust) RegulationCompetition Policy (Antitrust) Regulation
International legal normsCountries usually take a pragmatic position to enforcement.
The effectiveness of competition regulation depends on both the law itself and the stringency of its enforcement.
Competition law in the E.U. and the U.S. cannot be evaded by initiating the anti-competitive behavior outside the relevant territories.
Effects doctrine
Two principles
The principle of prohibition
The principle of abuse
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Regulation – Detecting Financial DifficultyRegulation – Detecting Financial Difficulty
Solvency surveillanceReporting requirements
Financial examination
On-site examination
Oversight by professions
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Regulation – Responding to Insurers in DifficultyRegulation – Responding to Insurers in Difficulty
Four optionsInformal actions
Formal actions
Rehabilitation
Liquidation
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Regulation – Policyholder ProtectionRegulation – Policyholder Protection
Two philosophiesNo protection based on true laissez-faire economics
Guaranty fund benefits
Guaranty fundsPre-insolvency assessment to all licensed insurers in the line(s) of business
Post-insolvency assessment
Guaranty funds diminish market discipline to some degree by creating moral hazard.
Researchers have proposed alternatives to the flat-assessment approach.
Taxation in Insurance
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Principles of TaxationPrinciples of Taxation
General purposes of taxationTo raise revenueTo promote economic goalsTo promote social goals
Desirable traits of tax policyEquity(Economic) neutrality – also called horizontal equitySimplicity
Systems of taxationTax basesTax exemptions, deductions and creditsTax rates
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Life Insurance TaxationLife Insurance Taxation
ConsumersMany countries provide tax relief to policyholders for premiums paid for qualifying life insurance policies. Table 24.2Dividends are not considered as taxable income, as they are chiefly a return to the policyholder of his or her own funds.Countries generally do not directly tax interest credited on policy cash values.
When taxed, the build-up is considered as part of benefits.The inside interest build-up of annuities during their accumulation period usually receives the same tax treatment as that of other life insurance products.
Most countries seem to tax annuity payouts to some degree.Most countries exempt death proceeds paid under qualifying life insurance policies from income taxation.
Governments commonly levy estate duties (taxes).
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Tax Relief on Life Insurance Premium Tax Relief on Life Insurance Premium (Table 24.2)(Table 24.2)
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Life Insurance TaxationLife Insurance Taxation
Life insurance companiesSeveral OECD countries and perhaps most developing countries levy taxes on insurers’ premium revenues.
Premium taxes are the most common.
Governments tax life insurers on some variation of net income or value added and sometimes both.
When using total income, governments permit several deductions in deriving taxable income.
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Nonlife Insurance TaxationNonlife Insurance Taxation
ConsumersPremiums paid by individuals for personal nonlife insurance policies are not deductible from income for tax purposes.
Exceptions exist.
Premium payments by businesses to purchase compulsory insurance and other business-related insurance are commonly tax deductible.
Benefits received under personal nonlife insurance policies are tax free.
Exceptions exist.
For benefits received by a business, such benefits are tax free in many countries.
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Nonlife Insurance TaxationNonlife Insurance Taxation
Nonlife insurance companiesCountries are less reluctant to impose premium taxation in nonlife insurance than in life insurance.
Moreover, tax rates with nonlife insurance are generally higher.Some governments levy other premium-based taxes that can greatly increase the effective tax in nonlife insurance.
Table 24.3Premium-based taxation is to be paid irrespective of insurer profitability.Governments usually tax nonlife insurance companies as other corporations.The great majority of countries seem to allow deductions for claims reported but unpaid and certain other reserves.The tax rates in most countries are the same as those applicable to other corporations and as for life insurers.
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Other Premium-based Taxes on Nonlife Other Premium-based Taxes on Nonlife (Table 24.3)(Table 24.3)
Discussion Questions
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Discussion Question 1Discussion Question 1
“The influence of interest rates on the trend in insolvency is not clear a priori, however, as two opposite effects exist. On the one hand, assets lose value when interest rates rise, which means that solvency is reduced. If a company in this situation is forced to dispose of assets in order to pay claims, it can get into payment difficulties. On the other hand, high interest rates also mean high current income from investments. High interest rates when a contact is arranged make it possible to reduce prices (this is known as “cash flow underwriting”). If interest rates fall and current investment income declines, the overall result deteriorates and the risk of insolvency increases.” Discuss which of these two effects you believe would be the more important. Why?
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Discussion Question 2Discussion Question 2
In the U.K. and Germany, no more than 10% of the earnings attributable to a stock life insurer’s participating (with bonuses) business may be distributed to shareholders. France limits such distributions to 15% of investment gains and 10% of all other gains. Italy limits distributions to 20% of investment gains. By contrast, the Netherlands and most states in the U.S. have no similar restrictions:
What public policy arguments support limitations on such distributions?
Why do believe that the Netherlands and many other countries have not such limitations?
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Discussion Question 3Discussion Question 3
Signatory countries to the GATS bind themselves to the fair-trade principles of market access, nondiscrimination, national treatment and transparency. GATS’s purpose is to create a more liberal market in trade in services in general and in financial services, including insurance, in particular. A provision within the agreement reads as follows:
[member countries] shall not be prevented from taking measures for prudential reasons, including for the protection of policyholders . . . or to ensure the integrity and stability of the financial system.
What is your interpretation of this provision?Do you believe that this provision is justifiable in view of a competitive insurance market internationally?The provision is quite general. Could you imagine that some countries might try to place a conservative interpretation of this provision and, if so, what measures might they take that you would believe to be inconsistent with the spirit of the provision?Could insurance be the cause of a country’s financial system loosing its integrity and stability? If so, how?
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Discussion Question 4Discussion Question 4
Explain why insurance is regulated.
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Discussion Question 5Discussion Question 5
Examine the insurance act in your country to answer the following:
What is the relationship between the insurance regulator and the government?Summarize the key provisions related to licensing insurers, reinsurers and insurance intermediaries. Does the act include a “fit-and-proper person” provision or equivalent?What information are insurance companies required to submit to the regulator?Do you find any sections relating to anti-competitive practices in the insurance industry?What are the steps that the regulator is empowered to take against insurance companies experiencing extreme financial or operational difficulty?
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Discussion Question 6Discussion Question 6
Analyze the premium tax using the desirable traits of tax systems.
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Discussion Question 7Discussion Question 7
Economies in transition have expressed interest in the possibility of stimulating the purchase of life insurance through tax concessions to its purchase.
Why might such countries want to promote the purchase of life insurance?
Would you expect such tax concessions to lead to increased sales of life insurance?
What effect might such tax concessions have on savings through other financial intermediaries and through government?
